R – I – B (The Solution To Indian Rupee)

Posted in Finance Articles, Total Reads: 3042
, Published on 22 December 2013

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“Rupee depreciation is more than what we can pass on” – R.K.Singh, Chairman and MD, BPCL.

The rupee saw levels of 68.80 against USD on Aug 28, 2013. The level closed 62.51 against USD on Sept 27, 2013. The volatility in the rupee has affected every sector which has had a foreign currency exposure on its balance sheet. These sectors include IT, BFSI, OMCs. The rupee depreciation alone has led to losses to many companies which had large exposures in the form of FCCBs, ECBs and other fancy foreign currency instruments. The rupee depreciation hits qualitative factors like sentiments which cause the NRIs, FIIs and other foreign funds and investors to pull out their money from the Indian economy.

Going by the economic theory:-

Thus, a Current Account Surplus and a Capital Account Deficit should match to stabilize the rupee after the Keynesian’s sticky effect is gone from the currency. India however has been structurally very inefficient in its various infrastructures relating to export incentives, custom duty and other such legal proceedings that despite rupee fall the exports did not pick up but we did well on the Imports front by proving the theory correct and our Imports became costlier. What resulted was Current Account Deficit (CAD) again despite rupee depreciation. Combine the CAD with Capital Account Deficit and voila we have made the perfect solution to depreciate the currency further.

Post Dr. Raghuram Rajan’s appointment as the Governor of RBI the rupee saw recovery and reached 63 65 levels. “ Raghuram Rajan is a rockstar man, he just saved the whole economy In one go” – said one of my friends. I being myself set out to make him understand the whole scenario first and then ended with a simple open ended question which he was to answer himself. The question I ended my discussion with was “So was it Raghuram Rajan’s Charisma or India’s Fundamentals or Ben Bernanke’s sweet music?”

Dr. Raghuram Rajan, the current RBI Governor and an IIT – IIM alumnus, Chief Economist to the IMF was the person who had foreseen the 2008 global crisis and had mentioned it in his research paper which he presented at an IMF conference only being referred to as “LUDDITE” by the former US Treasury Secretary Lawrence Summers. After joining the RBI office Raghuram Rajan brought in many unconventional measures like increasing the REPO rate amidst slow growth. However, the markets seemed to absorb the same, I wonder if it was Dr. D Subbarao would the market react the same way? I doubt it. Raghuram Rajan brings with him renewed vigor into the monetary policy. This vigor has definitely panned out well for the Rupee which appreciated amidst all of the measures brought in by Dr. Rajan. Other measures include decreasing MSF rate (rate at which banks can borrow over and above the REPO limit). A simple cost-benefit analysis would show how Dr. Rajan played a double whammy on Inflation and growth and kept both the ends happy. Let’s assume that Banking sectors IRR (Internal rate of return) before this measure is 10%. Banks have the option to borrow at 7.25% in the excess of its SLR securities from the REPO window and a further 2% of their NDTL from the MSF window. However, the MSF rate which was raised to 10.25% would not be accessed when my IRR is 10% because it will lead to negative spread and loss for a bank. Thus, Dr. Rajan helped the banks to increase their spreads by decreasing MSF rate and giving them incentive to invest more. On the other hand inflation in Consumer prices has touched 18.18% and in WPI above 6%. Thus, increasing the REPO rate will lead to lower inflation. Thus, rupee recovery can be pinned to Dr. Raghuram Rajan’s Charisma but if he is a rockstar or not is a matter of discretion.

“Rupee has to find the value depending on the fundamental macro-economic factors” – said Finance Minister P Chidambaram. However, I feel Keynesian thought process would add to it by saying that in the long run fundamentals only will affect the Rupee value. In the short run many other factors come into play. However, waiting for fundamental numbers to kick in and restrict rupee fall would take too long to render many companies unprofitable and the stock markets in a downfall. The numbers that came out like the IIP which remained below 2% levels for most of the period and inflation too remained outside the comfort zone. On the other hand, Gold Imports kept increasing. Economic theory would say that as prices go up for a commodity, its demand decreases. However, asset prices theory says that as prices go up the aesthetic value attached also goes up and thus it becomes a symbol of social status leading to higher purchases. This is what has happened with gold imports which increased as its price increased. Thus, fundamentals though did not change much in a 3-month span but still rupee depreciated to the tune of 19% during this period. It maybe overdue but the pace of fall has been alarming.

Ben Bernanke, the current chairman of the Federal Reserve hinted towards tapering of Quantitative Easing (QE). The implication of which in simple terms would be lower money supply or dollar supply with increasing interest rates in US. Thus the interest rate differential which till now was enjoyed by FII’s and other foreign investors by investing in India will now cease to exist and the money will be pulled out of India meaning lower liquidity in stock exchanges, lower FOREX reserves for import cover. The clear outcome of this would be Capital Account deficit and capital flight would dampen domestic investors’ sentiments which may lead to lower credit growth. So, as the possibility of QE tapering came in the market, the market reacted negatively to it leading to rupee depreciation. This depreciation started seeming like a free fall until the RBI intervened in the FOREX market but still could not control the fall with the reserves they had. A lot of measures came up in between leading to curbs on imports, rising import tariff rates, export incentives etc. However, the rupee fall could not be contained to comfortable levels.

The meeting of Federal Open Market Committee (FOMC) kick started on Sept 17, 2013 wherein the fate of QE was decided and FOMC took the decision of not tapering the QE measure as of yet because of the vulnerability in the US economy. The decision was taken favorably in the Emerging Markets which were major recipients of the QE money. Ben Bernanke having first hinted towards a QE tapering later led to a different stand of not tapering the same and the sweet music gave investors relief.

R – Raghuram Rajan’s Charisma

I – India’s Fundamentals

B – Ben Bernanke’s Sweet Music

The R – I – B has actually emerged as the most apt solution for the rupee which otherwise would have hurt many companies in the process. The gravity of the situation as such rupee depreciation can only be understood when we see that the rising oil subsidy due to rupee depreciation would push the fiscal deficit to 5% of GDP, as said by the INDIA RATINGS AND RESEARCH. In the budget of the current year the oil subsidy decided was Rs. 65,000 crore but this amount was allocated when rupee stood at 53 – 54 against USD.

The luxury car market has been booming in India and rupee depreciation has led to problems in the same as well. A Rolls Royce costing $ 9, 00,000 if imported in India would cost:-

DATE

COST (INR)

June 2, 2013

50,922,900

September 3, 2013

61,753,500

September 30, 2013

56,376,000

Such huge volatility would affect a growing market as well. Finance Minister P. Chidambaram believes that 58 59 is the true level for rupee. However, the solution to the Rupee problem was three fold as seen. R – I – B helped in the stabilization and recovery of the rupee at its current levels. One question still remains whether it’s sustainable given the fact that in the near future QE would be tapered once the US economy shows considerable signs of recovery? The question has its answer lying in the other two parts of the solution i.e. whether they will be able to increase their intensity and absorb the QE tapering if it happens.